Ofgem gives go-ahead to a £40 billion+ investment programme for a stronger, greener and fairer GB energy system

Publication date
8th December 2020
Information types
Policy areas
  • £30 billion upfront funding to deliver a clean and reliable energy system.
  • More than £10 billion on standby for future green energy projects where needed.
  • Shareholder returns significantly reduced to 4.30% contributing to £10 saving on average domestic bill.
  • £132 million package of support measures for vulnerable consumers.

Ofgem has finalised its price control for 2021-26 (RIIO-2) by confirming a major investment programme into Britain’s energy infrastructure to improve services for customers, reduce the impact of the networks on the environment, and drive a fair price for consumers.

Network companies run the pipes and wires that transport gas and electricity around Britain. They are funded through consumers’ bills, via five-year price controls set by Ofgem.

Ofgem has unveiled a spending package of £30 billion upfront funding for the companies. This is in total ~20% more than it previously proposed in July. Following its challenge to them, companies submitted much better evidence on their spending plans enabling Ofgem to green-light more funding for crucial service, maintenance, upgrades and repairs (1).

Ofgem is also making unprecedented additional funding available for future green energy projects. That is projects that companies propose over the next five years, aimed at eliminating emissions from the energy system and helping hit net zero targets across GB – a major aim of Ofgem’s price control.

Companies have indicated that £10 billion of such projects could be in the pipeline, such as reinforcement along the East Coast of England to anticipate 40GW of offshore wind in the North Sea. However there is no limit on the additional funding that could be provided, subject only to companies making good business cases. Ofgem has committed to working with companies and stakeholders to streamline its processes so that companies get funding without delay, when and where it’s needed.

Customers will also see a £2.3 billion saving over the course of RIIO-2, equivalent to an  average bill reduction of about £10 before inflation. The regulator has secured this by demanding greater efficiency from companies and lowering returns to shareholders by 40% to bring them in line with current market levels. As investment in green energy transformation rises over the coming years, this will make sure costs are kept as low as possible for consumers. (2)

Ofgem has made the following key changes since its July draft determinations, following 22,000 pages of further evidence:

  • Allowed return on equity 4.30% (a 4.55% cost of equity, when taken together with expected 0.25% income from quality / cost incentives) – increased from 3.95% at draft determinations.
  • £30 billion upfront funding to companies, increased from £25billion at draft determinations.
  • £132 million funding for vulnerable consumers, doubling to £60 million the vulnerability and carbon monoxide safety allowance from draft determinations. (3)

Meanwhile, in a separate price control, Ofgem is boosting funding for the electricity system operator to ensure that it stands ready, as soon as 2026, to operate a zero carbon emissions electricity system.

Ofgem’s Chief Executive Jonathan Brearley said: “Our £40 billion package massively boosts clean energy investment. This will ensure that our network companies can deliver on the climate change ambitions laid out by the Prime Minister last week, whilst maintaining world-leading levels of reliability.

“These costs must fall fairly for consumers. We are reducing the amount paid to shareholders so that they are closer to current market levels. This means that companies can attract the vital investment we need whilst making sure that consumer don’t pay more than is necessary to achieve this.

“We are also ensuring that £132 million is earmarked to support the most vulnerable in society, including carbon monoxide initiatives and funding new connections for those most struggling with their bills.”

Notes to editors

(1) The above package relates to Gas Transmission (GT) and Electricity Transmission (ET), Gas Distribution (GD), and the Electricity System Operator (ESO) for the five-year price control beginning April 2021. This does not apply to the Electricity Distribution network companies have a separate price control, beginning April 2023.

The £30 billion package breaks down as:

Final determinations

ET

GT

GD

ESO

Total

Totex

Baseline Totex and other totex related allowances including volume adjustments, price adjustments and other similar allowances

9,886

2,092

10,053

1,286

23,318

Pass through costs

Non controllable costs such as business rates, licence fees and pension costs

941

764

4,002

31

5,737

Other Allowances

Including innovation and other similar allowances

204

145

153

46

549

Total upfront funding

11,031

3,001

14,208

1,363

29,604

(2) Ofgem’s proposals, based on current market conditions, set a cost of equity at 4.55%(in CPIH real terms) but the allowed baseline return on equity for network companies is set at 4.30% (CPIH) for a notional company with 60% gearing. The proposed gap between allowed return on equity and cost of equity represents our judgement, based on past experience and the proposed RIIO-2 incentives, as to the minimum degree to which the companies can be expected to outperform their allowed return on equity.

This proposed allowed return is around almost 40% lower than under the previous price control (RIIO-1) and the lowest ever cost of capital rate for energy network companies.

This, along with other factors such as greater efficiency measures, will lead to an estimated reduction of around £10 per year on the average domestic bill

The savings figures include only the transmission and gas distribution networks over this five year price control, and exclude the electricity distribution networks. The electricity distribution sector price control (ED2) runs two years behind the other sectors and decisions are still subject to further consultation. The measures differentiating allowed return on equity and cost of equity do not apply to the Electricity System Operator (ESO).

TABLE: Cost of capital for average network companies* - comparison of our final determinations (FD) with July draft determinations (DD)

Component

DD

FD

Notional gearing

60.00%

60.00%

Cost of equity

4.20%

4.55%

Expected Outperformance

0.25%

0.25%

Allowed return on equity

3.95%

4.30%

Allowed return on debt

1.74%

1.82%

Weighted Average Cost of capital

2.63%

2.81%

*Please note this does not apply to ESO

Ofgem has increased the cost of capital since its draft determinations. Ofgem takes several factors into account when proposing a rate of return on equity. One factor is ‘beta’, a measure of systemic risk for companies compared with the market as a whole. This measure is only available for listed companies, but with no comparable listed energy networks, we have to use water companies as a proxy for a similar regulated utility. During its consultation, Ofgem received new evidence from National Grid demonstrating that their beta can at times be higher than water companies. This is why Ofgem has now allowed a larger allowed return on equity.

(3) Ofgem’s £132 million package of measures to help support consumers in vulnerable situations covers the gas distribution sector and comprises:

  • A new £60 million fund for consumers in vulnerable situations and carbon monoxide safety
  • Continuation of Fuel Poor Networks Extension Scheme (FPNES) – worth around £60 million – which in tandem with government schemes - helps tackle fuel poverty by supporting fuel poor households to connect to the gas network and access affordable heating.
  • Tailored welfare support to Cadent consumers in vulnerable situations in the event of a supply interruption including food vouchers, rechargeable showers and electric kettles. We have enabled them to do this, with an additional £12.4 million of funding.

Further information

Ofgem’s RIIO-2 Final Determinations for Transmission and Gas Distribution network companies and the Electricity System Operator

For further press information contact

Ruth Somerville: 0207 901 7460/ 07990 139504

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For investor relations contact:

Jamie Tunnicliffe: 07799 478 539 / jamie.tunnicliffe@ofgem.gov.uk, or; 

Aidan Stringfellow: 07387 049 764 / aidan.stringfellow@ofgem.gov.uk

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